Most business startups get their first investment from friends and family of the founders in what's called the pre-A investment round. Once the business has been in operation long enough to exhibit a potential for success, angel investors get involved. This is the A or seed-round investment level. Structuring these investment deals properly helps protect the interests of both your business and the investors.

What Your Investors Want In a Deal

The first thing your investors want is documentation of their investment. They want to minimize the risk of losing money and to see the potential for making money. Sometimes your friends and family want to be part of the business decision-making process, but normally they are investing in your business because they want to help you achieve a dream. Angel investors are wealthy individuals who look for early investments in potentially successful companies. They are interested in making money and usually require a legal private placement offering in compliance with the Securities and Exchange Commission Regulation D, Rule 506.

Keep Friends and Family Deals Simple

One of the best ways to bring in startup investment from friends and family is to include them when you incorporate and divide the issued shares of your company among the founders. If you create an LLC instead of a C-corporation, your investors will become members of the LLC and you will be issuing them certificates of interest instead of stock. This avoids costly legal fees and compliance with SEC regulations, but you must be able to demonstrate that they are close family and friends who know you and are intimately familiar with your company. Don't do this with outside investors you don't know well, because that can be a violation of SEC regulations.

Offering to Accredited Investors

If you need additional funding, initiate a Regulation D private placement of stock or convertible promissory note. It's always advisable to hire an experienced attorney to prepare the documents for any funding from outsiders. A convertible promissory note is a loan that allows the investor to exchange the note for stock in your company. Your investors or lenders attest to being accredited investors and you demonstrate that you believe them to be accredited investors. An accredited investor is one who has an individual or joint net worth of at least $1 million, excluding primary residence, or reliable annual income of $200,000 if single or $300,000 if married, and has earned at this income level for the two previous years. There are other rules that apply to accredited investors, so check with your attorney or the SEC if you anticipate receiving outside investment.

SEC Regulation D

Your private placement of stock or convertible promissory notes must be done under the SEC's Regulation D, which exempts your private issue of securities from registration with the SEC. Most private placements are done under Rule 506, which allows you to raise an unlimited amount of money. Your attorney should prepare the private placement memorandum, the accredited investor questionnaire and the subscription agreement for you, but it is helpful if you have a complete business plan to be used in preparing the PPM and as supporting documentation for your investors' information.

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